Important calendar events
The dollar dipped on Monday and the dollar index dived from 105.3 to 105.1. US Treasury yields remained firm, with the US 10-year bond yielding above 4.32%.
The dollar is expected to be driven in the next few weeks by Fed rate hike expectations. The U.S. Federal Reserve raised interest rates by 25 basis points in July to a target range of 5.25% to 5.50%, the highest level in 22 years.
The Fed is widely expected to keep interest rates unchanged after its policy meeting this week on Wednesday the 20th. FOMC Economic Projections on Wednesday will be of special interest to market participants looking for forward guidance. Odds that the Fed will raise interest rates one more time this year are increasing, although most analysts predict that the Fed has already reached its rate ceiling. The US economy is showing signs of picking up, giving the Fed more leeway to raise interest rates. At the same time, inflationary pressures are proving quite stubborn and may force the Fed to continue its hawkish policy.
US inflationary pressures are not easing just yet, despite the Fed’s high-interest rates. PPI rose by 0.7% in August, exceeding expectations of a 0.4% rise. Core PPI, which excludes food and energy, decelerated a little, rising by 0.2% in August compared to a 0.4% growth in July. Rising fuel costs are largely to blame for the stubbornly high inflation rates in the US.
Consumer inflation is also accelerating, with CPI rising by 0.3% in August from 0.2% in July against expectations of a 0.2% print. Headline inflation came in hotter than anticipated, climbing to 3.7% year-on-year in August from 3.2% in July versus 3.6% anticipated. Core inflation, which excludes food and energy, also rose by 0.3% in August from 0.2% in July. Increasing price pressures may push the Fed to continue its hawkish policy until inflation drops closer to the Fed’s 2% target.
Preliminary GDP for the second quarter of 2023 showed that the US economy expanded by only 2.1% against expectations of 2.4% growth. The preliminary GDP price index for the 2nd quarter of the year also came in below expectations at 2.0% versus 2.2% anticipated.
EUR/USD rose in early trading on Monday, climbing to 1.070 but pared some gains later in the day, dropping back to 1.067. If the EUR/USD pair declines, it may find support at 1.063, while resistance may be encountered near 1.076.
The ECB raised interest rates by 25 bp at its monetary policy meeting last week, bringing its main refinancing rate to 4.50%. The ECB had the difficult task of assessing the risk to the fragile Eurozone economy against high inflation rates. In the end, persistently high inflation induced the central bank to raise interest rates again on Thursday.
The ECB hinted that it had reached its interest rate ceiling, putting pressure on the Euro. ECB President Christine Lagarde signaled an end to rate hikes at the press conference after the conclusion of the meeting but warned that interest rates will remain at sufficiently restrictive levels for as long as necessary.
Final GDP data for the Euro area were disappointing, showing that the Eurozone economy expanded by only 0.1%, in the second quarter of the year, against expectations of 0.3% growth. The Eurozone economy barely grew in the second quarter after contracting by 0.1% in Q1 of 2023. The EU economy is struggling and cannot withstand much further tightening.
Flash CPI data for August showed that Euro Area headline inflation remained unchanged at 5.3% year-on-year against expectations of a drop to 5.1%. Core CPI, which excludes food and energy, however, dropped to 5.3% from 5.5% in July.
Final CPI and Core CPI data are due on Tuesday for the Eurozone and may affect the Euro in the wake of the ECB meeting last week.
The Sterling traded sideways against the dollar on Monday, with GBP/USD oscillating around the 1.238 level. If the GBP/USD rate goes up, it may encounter resistance near 1.255, while support may be found near 1.231.
Britain’s economy contracted by 0.5% month-on-month in July after expanding by 0.5% in June. The prognosis was more optimistic, with markets forecasting a 0.2% decline in GDP. The state of the British economy is fragile, as prolonged tightening has taken its toll on the labor market and other vital economic sectors. The British economy weakened more than expected in July and this may play a decisive role in the BOE’s monetary policy decision this week.
High inflation in the UK is putting pressure on BOE policymakers to increase interest rates. Inflation in the UK is showing signs of cooling, demonstrating the effectiveness of the BOE’s consistently hawkish policy. Headline inflation dropped to 6.8% year-on-year in July from 7.9% in June. Core CPI, which excludes food and energy, remained steady at 6.9% though. Even though inflationary pressures in the UK are easing, inflation is still high, and policymakers are likely to continue raising interest rates to bring it down.
The BOE raised interest rates by 25 basis points at its latest policy meeting, bringing the bank rate to a 15-year high of 5.25%.
A combination of a struggling economy and high inflation is making the BOE’s task more difficult. Further tightening is needed to bring inflation down at the risk of tipping the British economy into recession. The BOE will announce its interest rate decision this week on the 21st. The BOE is seen as likely to continue raising interest rates and markets are pricing in another 25-bp rate hike on Thursday.
The interest rate decision this week is unlikely to be unanimous as in recent votes some MPC members were more dovish than others. Nevertheless, market odds are in favor of yet another rate hike in November and a lot is riding on the forward guidance the BOE will give this week. The BOE rate votes on Thursday and the Monetary Policy Summary will be scrutinized by traders for hints into the central bank’s future policy direction.
The Yen traded sideways against the dollar on Monday with USD/JPY fluctuating around the 147.8 level. If the USD/JPY pair declines, it may find support near 145.8. If the pair climbs, it may find resistance at 148. Monday was a Bank Holiday in Japan and the Yen moved mostly by BOJ expectations for this week’s meeting.
The BOJ maintained its short-term interest rate target steady at -0.10% at its latest policy meeting in July but loosened its yield curve control.
Another BOJ monetary policy meeting will be held this week on Friday the 22nd. The ECB already hiked rates one more time last week and the BOE is likely to follow suit on Thursday, while the Fed is seen as likely to pause raising interest rates this week but deliver a hawkish message. The Yen becomes even more vulnerable as other major central banks continue raising interest rates.
The BOJ is almost certain to maintain its negative interest rate on Friday. Markets, however, will be focused on the BOJ’s forward guidance as the central bank is finally showing signs of relaxing its ultra-easy policy.
BOJ Governor Kazuo Ueda hinted last week that a policy shift may finally be on the horizon. Ueda admitted the BOJ will be exploring new policy options if economic and price conditions continue moving upward. Ueda warned that the present ultra-easy policy will continue for some time but indicated that the BOJ is considering policy adjustments further down the track. Even though Ueda has hinted at a policy shift, a policy change is not imminent and will depend on future economic and inflation data.
The Yen has been weakening, pushed down by the BOJ’s ultra-accommodating monetary policy. The Yen’s weakness has been the subject of concern for Japanese authorities as it undermines the country’s importing potential and causes financial distress in households.
Japanese authorities have been repeatedly warning speculators against excessive short-selling of the Yen. The Yen’s continued weakness is raising market awareness of another intervention by the Japanese currency to support the ailing currency. Many market analysts view the USD/JPY 150 level as the line in the sand for another intervention.
National Core CPI dropped to 3.1% in July from 3.3% in June. Inflation in Japan has remained above the BOJ’s 2% target for more than a year, encouraging the BOJ to tighten its monetary policy. BOJ Core CPI dropped slightly to 3.0% in July from 3.1% in June.
Final GDP data for the second quarter of the year showed that the Japanese economy expanded by 1.2%, disappointing expectations of 1.4% growth. The final GDP Price Index showed a 3.5% annual expansion, versus 3.4% the previous quarter. Japan’s economic recovery increases the odds of a hawkish pivot in BOJ’s monetary policy.
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Written by:
Myrsini Giannouli
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